Transcript:What Is a Subprime Mortgage?

What's a Subprime Mortgage?

Those two words -- subprime mortgage -- are now synonymous with the financial crisis of late 2007 and beyond. Subprime mortgages, that is mortgages provided by lending institutions to people with less than perfect credit, were the foundation of a series of financial moves which many credit with causing the financial collapse in the United States.

The American Dream and Subprime Mortgages

The roots of subprime lending started nobly enough. The idea: To give more people access to the American dream of owning a home. That idea expanded to creating opportunities for people who may not have been in a position to afford a mortgage under a bank's normal lending requirements.

United States Housing Boom

Exacerbating the issue with taking on more risk, was the fact, banks were often willing to make subprime mortgages available with little to no money down. The immediate effect of opening up mortgages created a boom in the housing industry. Suddenly, there was a glut of potential new homeowners who flooded the mortgage market. Attractive rates drove up housing prices, and demand for housing outstripped supply.

Under-Regulated Mortgages

In an under-regulated mortgage and investment industry, subprime mortgages began to be bundled with prime mortgages -- those provided to people with good credit ratings.

Types of Mortgages

Those two kinds of mortgages, prime and subprime, were then bundled into investment vehicles called mortgage backed securities. The basic idea: Charge subprime mortgage holders higher interest rates. Bundle them with prime mortgages with lower interest rates. Offer investors of the two, a guaranteed can't miss return somewhere in the middle. And it's a win-win.

Mortgage Backed Securities

Investors would buy these securities, which often had the backing of investment houses. But problems quickly arose from those securities, as they were often represented as being more stable than they actually were. In fact, many of the subprime mortgage holders defaulted on their loans, meaning the mortgage backed securities could not deliver on their promised returns.

The U.S. subprime mortgage industry was valued at somewhere near $1.3 trillion at its peak in 2007, with more than 7.5 million subprime mortgages offered. And that's a look at the subprime mortgage and it's impact on the U.S. economy.

Thanks for watching, I'm Jim Flink. For more information, be sure to check out About.com.

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